The notorious collapse of Carillion in 2018 led then-business secretary Greg Clark to declare that the lessons learned from the government contractor’s failure should be applied “without delay”.
Now, five years on, an ambitious package of proposed corporate governance reforms developed post-Carillon has resulted in few changes to the laws that regulate directors and auditors.
The Conservative government’s plans were aimed at overhauling three key areas: the responsibilities of company directors; the audit industry; and the “ramshackle” accounting regulator.
But ministers have delayed the shake-up of the UK’s audit and corporate governance regimes, meaning the long-trailed plans will probably not be enacted during the current Parliament that will end by January 2025.
The changes were excluded from Tuesday’s King’s Speech that set out the legislative agenda for the next year, while the UK accounting regulator simultaneously pared back changes to the country’s corporate rule book.
Five years, six business secretaries and more than 950 pages of reviews and consultations later, the Tory government is now focused on reducing red tape for businesses and shoring up London’s capital markets.
City minister Andrew Griffith said the Financial Reporting Council’s decision to drop most of its 18 planned changes to the corporate governance code was “pragmatic and proportionate”.
But Paul Eagland, managing partner at BDO, the UK’s fifth-largest accounting firm, said businesses needed faster progress and a clear picture of what the final reform package would include.
“After five years . . . having clear, proportionate, intelligent but final proposals is just so important,” he said.
Holding companies to account
At the centre of the original reforms was a proposal to require directors to sign off on companies’ internal controls and make an annual statement about their effectiveness.
The idea was loosely modelled on the US’s Sarbanes-Oxley Act, introduced after the failure of energy group Enron two decades ago, but prompted concerns from businesses about compliance costs.
Ministers last year dropped plans to put the reform into legislation, instead saying they would add a provision to the corporate governance code.
The code applies only to companies with a premium listing on the London Stock Exchange. Companies can ignore its requirements if they explain why they are doing so.
The change prompted the head of one Big Four firm to say: “It feels like you’re the goalkeeper and they’ve not invested in the defence.”
But even this watered down version has not been enacted.
The FRC on Tuesday delayed again the implementation of the new internal controls rules in the code to ensure that “the UK approach clearly differentiates from the much more intrusive approach adopted in the US”.
“The directors’ [annual] attestation was a huge driving force of that increased accountability,” said Andrew Walton, EY’s UK head of audit.
Until the FRC publishes its updated proposals and detailed guidance to explain how it will work, companies face uncertainty over what they will be asked to do under the new regime, he added.
The government also planned to increase the number of public interest entities (PIEs), which are subject to stricter audit and governance standards, from about 2,000 to as many as 4,000.
The latest proposals would classify only about 600 extra larger companies as PIEs.
Overhauling the audit sector
Plans to overhaul the audit sector centred on two elements: diluting the Big Four’s market dominance and improving the quality of auditors’ work.
The Big Four successfully resisted early calls to have their audit arms split from their consulting operations. Instead they agreed with the regulator to a voluntary “operational separation” by 2024 to boost audit independence.
This required the firms to end cross-subsidies from advisory to audit and to ensure that auditors were paying a market rate for any expertise they buy in from their consultant colleagues.
The Big Four remain dominant in the audit sector — checking the books of 98 of the FTSE 100 as of August, according to Adviser Rankings.
A plan to force the biggest listed companies to give at least part of their audit work to smaller accountancies remains up in the air because implementing the changes would require as yet unpublished legislation.
To improve audit quality, the FRC has increased its staffing and toughened its sanctions for substandard work.
A £21mn fine for KPMG’s failings at Carillion and a £15mn penalty for Deloitte’s work at former FTSE 100 software group Autonomy were the heftiest in a slew of sanctions.
Run-of-the-mill supervision has also become tougher, with the FRC pointing to improving scores in annual inspections as evidence that its approach has led to better audits.
The regulator’s stricter approach has led auditors to charge more for their work, contributing to a sharp rise in audit fee income at the big firms — 34 per cent in the past five years — even as they have cut client numbers to reduce regulatory risk.
Fixing the “ramshackle” regulator
In his 2018 review of the FRC, former Treasury mandarin Sir John Kingman described the watchdog as a “ramshackle house” and concluded that it should be replaced by a beefed-up regulator with broader powers.
Establishing the Audit, Reporting and Governance Authority (Arga) was a major part of the government’s reforms but it too has been put on hold as the agency’s creation requires legislation.
The government’s 2021 audit and governance consultation outlined plans to give the new regulator powers to investigate and impose sanctions against company directors guilty of wrongdoing.
Under current rules, the regulator is powerless to intervene unless a company director happens to be a chartered accountant.
Anne Kiem, chief executive of the Chartered Institute of Internal Auditors, said legislation was “urgently needed” to create Arga and give it “the legal powers it needs to hold company directors and audit firms to account”.
New FRC chief executive Richard Moriarty said this week that the regulator would “continue to utilise its current regulatory toolkit”, balancing its public interest remit with “promoting UK corporate growth and competitiveness”.
Although Arga’s creation has been put on ice, the FRC’s headcount has grown from less than 200 in 2017 to more than 480 today, helping it to beef up its enforcement actions against auditors.
Corporate governance experts have grown exasperated by the delays.
“Audit reform is vital to restoring investor trust in financial statements,” said Peter Swabey, policy and research director at the Chartered Governance Institute. “The government has failed to listen.”
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